If you’ve reached age 70½, you can make cash donations to IRS-approved charities out of your IRA. These so-called qualified charitable distributions (QCDs) are now a permanent feature of the tax law — unless Congress changes its mind. To take maximum advantage for 2018, you should replace some or all of this year’s IRA required minimum distributions with tax-smart QCDs. Here’s what you need to know.
Qualified charitable distribution basics
Qualified charitable distributions (QCDs) can be taken out of your traditional IRA(s) free of any federal income hit. In contrast, other traditional IRA distributions are taxable (wholly or partially depending on whether you’ve made any nondeductible contributions over the years).
Unlike garden-variety charitable donations, you can’t any claim itemized deductions for QCDs. That’s OK, because the tax-free treatment of QCDs equates to a 100% deduction — because you’ll never be taxed on those amounts, and you don’t have to worry about any of the tax-law restrictions that apply to itemized charitable write-offs.
A QCD must meet all the following requirements.
1. It must be distributed from an IRA, and it cannot occur before you, as the IRA owner or beneficiary, are age 70½.
2. It must meet the normal tax-law requirements for a 100% deductible charitable donation. If you receive any benefits that would be subtracted from a donation under the normal charitable deduction rules, (such as free tickets to an event), the distribution cannot be a QCD. Beware of this rule!
3. It must be a distribution that would otherwise be taxable. A Roth IRA distribution can meet this requirement if it’s not a qualified (meaning tax-free) distribution. However, making QCDs out of Roth IRAs is generally inadvisable for reasons explained later in this column.
Important Point: If you inherited an IRA from the deceased original account owner, you too can do the QCD drill with the inherited account if you’ve reached age 70½.
$100,000 annual limit
There is a $100,000 limit on total QCDs for any one year. But if both you and your spouse both have IRAs set up in your respective names, each of you is entitled to a separate $100,000 annual QCD limit, for a combined total of $200,000.
Tax-saving advantages
QCDs have five potential tax-saving advantages.
1. QCDs are not included in your adjusted gross income (AGI). This lowers the odds that you will be affected by various unfavorable AGI-based rules — such as those that can cause more of your Social Security benefits to be taxed, less of your rental estate losses to be deductible, and more of your investment income to be hit with the 3.8% Medicare surtax (the so-called net investment income tax). QCDs are also exempt from the rule that says your itemized charitable write-offs cannot exceed 60% of your AGI (any donations disallowed by the 60%-of-AGI limitation are carried forward for up to five years).
2. QCDs always deliver a tax benefit while “regular” charitable donations might not. The TCJA almost doubled the standard deduction amounts, and you only get a tax benefit from a charitable donation if your total itemizable deductions exceed your standard deduction. So higher standard deductions make it that much harder to claim itemized charitable write-offs. For 2018, the standard deductions are:
* $12,000 if you are single or use married filing separate status (up from $6,350 for 2017).
* $24,000 if you are a married joint-filer (up from $12,700).
* $18,000 if you are a head of household (up from $9.350).
3. A QCD from a traditional IRA counts as a distribution for purposes of the required minimum distribution rules. Therefore, you can arrange to donate all or part of your 2018 required minimum distribution amount (up to the $100,000 limit) that you would otherwise be forced to receive before yearend and pay taxes on. But hurry, because you must either take your 2018 required distribution by yearend or take the alternate tax-smart QCD route.
4. Say you own one or more traditional IRAs to which you have made nondeductible contributions over the years. Your IRA balances consist partly of a taxable layer (from deductible contributions and account earnings) and partly of a nontaxable layer (from those nondeductible contributions). Any QCDs are treated as coming first from the taxable layer. Any nontaxable amounts are left behind in your IRA(s). Later on, those nontaxable amounts can be withdrawn tax-free by you or your heirs.
5. QCDs reduce your taxable estate, although that is not an issue for most folks now that the federal estate tax exemption has been supersized to $11.18 million for singles and effectively $22.36 million for married couples.
Are you a good QCD candidate?
If you can afford to donate IRA money, you can benefit tax-wise if you match one or more of the following profiles.
1. You don’t itemize deductions (under the normal rules only itemizers get any income tax benefit from charitable donations).
2. You itemize, but part of your charitable deduction would be delayed by the 60%-of-AGI restriction.
3. You want to avoid being taxed on the required minimum distribution amount that you must take from your IRA(s).
4. You are looking for a quick and easy estate tax reduction strategy.
Should you consider Roth QCDs?
Generally, the answer is no. Why? Because you and/or your heirs can take federal-income-tax-free Roth IRA withdrawals after at least one Roth account owned by you has been open for at least five years. Also, for original account owners (as opposed to account beneficiaries), Roth IRAs are not subject to the required minimum distribution rules until after you pass on. Bottom line: because the tax rules for Roth IRAs are so favorable, it’s generally best to leave your Roth balances untouched rather than taking money out for QCDs.
The bottom line
The QCD privilege is a tax-smart opportunity for well-off seniors with more IRA money than needed for retirement. However, this is also a timely opportunity, because you want to arrange for QCDs to replace IRA required minimum distributions for this year.